Company Reports

We are initiating coverage of Air France-KLM with a no-moat rating and a fair value estimate of EUR 9 on the back of continued strong travel demand, gradual capacity recovery, and operational efficiency, resulting in improved profitability and cash flow generation.

Air France-KLM is a European network carrier utilizing a hub-and-spoke model. Its two major hubs are Charles de Gaulle Airport in Paris and Schiphol Airport in Amsterdam.

We are dropping coverage of Air France-KLM. We provide broad coverage of more than 1,500 companies globally and periodically adjust our coverage according to investor interest and staffing.

Air France-KLM reported a very good set of results, generating EUR 386 million EBIT in the second quarter, which is a EUR 1.1 billion improvement on the prior-year comparable period and approaching precoronavirus levels. This strong performance was driven by a return to profitability for the network airlines as traffic continues to recover and the group starts reaping the benefits of cost-saving measures. We maintain our EUR 3.70 fair value estimate with shares in deep discount territory, but we still have a Morningstar Uncertainty Rating of Very High as there is still a lot of work to be done to restore the balance sheet and repay government-aided loans.

We reduce Air France-KLM’s fair value estimate to EUR 3.70, from EUR 5.20, as we incorporate the EUR 2.26 billion rights issue into our model. The reduction in our fair value is entirely attributable to the deeply discounted subscription price of EUR 1.17 per share, which compares with our previous forecast of a rights issue done at EUR 2.50. We also change our uncertainty rating to very high from extreme. We believe there is still lots of work to be done in terms of restoring the balance sheet, but at least some level of certainty is achieved with the announcement. Shares appear attractive, but we caution about the wide range of outcomes as a result of group indebtedness and the uncertainty around the recovery in air traffic demand. We prefer the low-cost carriers Ryanair, Wizz Air, and EasyJet, which are all trading at attractive discounts with relatively lower risk.

Air France-KLM is a European network carrier with major hubs at Charles de Gaulle Airport in Paris and Schiphol Airport in Amsterdam. The coronavirus dealt a heavy blow to the global airline industry, including Air France-KLM, whose balance sheet has been devastated. To shore up liquidity the group has received EUR 10.4 billion in state backed bailouts. The EUR 4 billion restructuring of the French state backed loans in April 2021 was not enough to plug the hole in the group’s balance sheet and comes with heavy restrictions, such as excluding the group from engaging in acquisitions. The group announced an additional EUR 2.56 billion rights issue in May 2022, while additional capital restructuring is required to fully restore the group's balance sheet. The high levels of indebtedness, low visibility, and high probability of further equity value destruction is reflected in our very high uncertainty rating.

Air France-KLM announced a EUR 2.26 billion rights issue as part of its effort to recapitalize the EUR 4 billion hole in its balance sheet and repay state aid. The second rights issue since the start of the pandemic will be heavily dilutive for nonparticipating shareholders at a price of EUR 1.17 per share and three shares for every existing share held, translating into a 75% dilution. Our existing forecast and fair value estimate made provision for a EUR 3 billion rights issue at EUR 2.50. We expect to lower our EUR 5.20 fair value estimate as a result of the deep discount. We have had the group on an extreme uncertainty rating for some time owing to its weak balance sheet. We will revisit our rating once it its clear that the group is adequately recapitalized.

Despite the first quarter of the year being negatively affected by the omicron variant, war in Ukraine, rising fuel costs and strict Chinese lockdowns--Air France-KLM managed to exceed expectations and reported positive EBITDA of EUR 221 million. Free cash flow of EUR 630 million in the first quarter has now been positive for four quarters in a row and is largely driven by the return of advanced ticket sales as the booking window lengthens. Seat capacity was at 75% of 2019 levels in the first quarter, reaching 80% of precoronavirus levels by March. The outlook is positive--network capacity is expected to reach up to 90% of 2019 levels by summer while yields are tracking ahead of pre-COVID-19 levels due to high pent-up demand and low industry capacity. Operating profits are expected to reach break-even in the second quarter and be “significantly positive” in the third quarter.

Germany’s boost in defense spending, announced Feb. 27, will benefit most European defense contractors and could lead to multiyear increases in the growth outlook for these companies. While it is early days and very difficult to quantify the exact impact, we expect to make positive adjustments to our defense coverage. Of the pure-play defense names, narrow-moat Thales, Dassault, and Leonardo trade at discounts to our fair value estimates while wide-moat BAE Systems trades at a premium. We don’t believe our revisions will change this ranking by much, and our preference is for Thales and Dassault. Despite the impact from a demand and cost perspective on the airline and commercial aerospace companies we cover, we don’t foresee any structural long-term changes to their prospects and as such don’t anticipate any major changes to our fair value estimates. We maintain our preference for wide-moat Safran and no-moat Wizz Air under our aerospace and airline coverage, respectively.

No-moat Air France-KLM announced that it requires up to EUR 4 billion to restore its balance sheet and free itself from state bail out restrictions. We lower our fair value estimate to EUR 5.20, from EUR 6.40, as we incorporate the dilutive effect of a capital restructuring into our forecasts. The group received EUR 10.4 billion in state aid as a result of the heavy blow the pandemic dealt to the group’s balance sheet. The EUR 4 billion restructuring concluded in April last year was not enough to shore up the group’s finances. The balance sheet suffers from gross debt of EUR 16.2 billion and a negative equity balance of EUR 3.8 billion. The form and timing of the EUR 4 billion anticipated capital raise has not been announced, but it could be in the shape of a rights issue or debt to equity conversion--either way it will have a dilutive effect for existing shareholders given the market value is only EUR 2.8 billion. Shares are trading down nearly 8% intraday. We reiterate our extreme uncertainty rating and the potential for shareholder value destruction as a result of the high debt levels.

Air France-KLM is a European network carrier with major hubs at Charles de Gaulle Airport in Paris and Schiphol Airport in Amsterdam. The coronavirus dealt a heavy blow to the global airline industry, including Air France-KLM, whose balance sheet has been devastated. To shore up liquidity the group has received EUR 10.4 billion in state backed bailouts. The EUR 4 billion restructuring of the French state backed loans in April 2021 was not enough to plug the hole in the group’s balance sheet and comes with heavy restrictions, such as excluding the group from engaging in acquisitions. An additional capital raise of up to EUR 4 billion is required to restore the equity base and free the group from restrictions. The shape and timing of the capital restructuring is unknown, but it will undoubtedly be dilutive to existing shareholders. The low visibility and high probability of value destruction is reflected in our extreme uncertainty rating.

Air France-KLM is a European network carrier with major hubs at Charles de Gaulle Airport in Paris and Schiphol Airport in Amsterdam. The coronavirus dealt a heavy blow to the global airline industry, including Air France-KLM. We believe the crisis presents the group with a unique opportunity to restructure its cost base and renegotiate restrictive labor policies. The more imminent item on the group’s agenda is its unsustainable capital structure, which requires urgent restructuring. As a result, we are negative on the prospects for the group to generate shareholder value due to the high probability of value destruction.

The recovery in air travel is flowing through to no-moat Air France-KLM’s bottom line, as the group reported the first positive EBITDA of EUR 796 million since the start of the crisis in March 2020. Free cash flow of EUR 278 was positive for the second quarter running, largely boosted by advanced ticket sales as travel between North America and Europe start opening up over the Christmas period. Net debt decreased by EUR 200 million to EUR 8.1 billion since the end of the second quarter. Liquidity of EUR 10.3 billion should be sufficient to cover the near-term restructuring, capital expenditures, and debt repayments. The key development for investors to follow is the second round of capital restructuring, which could include a combination of fresh equity up to EUR 3.5 billion (current market value of EUR 2.5 billion) and/or the restructuring of the Dutch state loans. No target date has been given for the restructuring. We increase our fair value estimate slightly to EUR 6.40, from EUR 6.10, as we incorporate higher traffic for 2021. Shares are trading in discount territory, but we caution investors of the extreme uncertainty due to risk of equity value destruction as a result of the group’s high financial gearing.

Signs of a recovery are visible as no-moat Air France-KLM reported the best quarter since the start of the pandemic. Second-quarter 2021 revenue of EUR 2.7 billion was the highest, while an EBITDA loss of EUR 248 the lowest since March 2020. The group generated EUR 210 million of free cash flow in the quarter, largely thanks to advanced ticket sales, which contributed to the approximately EUR 300 million reduction in net debt to EUR 8.3 billion, from the end of first-quarter 2021. Liquidity of EUR 9.4 billion should be sufficient to cover the roughly EUR 3 billion in near-term restructuring, capital expenditures, and debt repayments. The key development for investors to follow is the second round of capital restructuring, which could include a combination of fresh equity up to EUR 3.5 billion (current market value of EUR 2.6 billion) and/or the restructuring of the Dutch state loans. No target date has been given for the restructuring. We maintain our EUR 6.10 fair value estimate, which suggests attractive upside, but caution investors of the extreme uncertainty due to risk of equity value destruction as a result of the group’s high financial gearing.

The slow recovery in air travel continues to challenge no-moat Air France-KLM as the group reported an operating loss of EUR 1.2 billion in first-quarter 2021, slightly ahead of previous guidance. Free cash outflow of EUR 1.3 billion remains affected by the lack of advanced sales and high level of ticket refunds. The net debt position after quarter-end of EUR 8.6 billion improved from the 2020 year-end EUR 12.3 billion figure, largely due to the EUR 4 billion initial capital restructuring announced in April (details of the restructuring are contained in our note published on April 6). We believe available liquidity of approximately EUR 9.5 billion is sufficient to fund group operations and obligations over the short term, but further restructuring is required to fully restore the balance sheet, details of which are expected to be announced at the group’s AGM later on May 26. The short-term outlook lacks visibility, especially given the group’s high exposure to Europe, which is lagging other developed regions with the coronavirus vaccine rollout. We maintain our EUR 6.10 fair value estimate, but caution investors of the extreme uncertainty due to risk of equity value destruction as a result of the group’s high financial gearing.

No-moat Air France-KLM announced an initial capital restructuring program totaling EUR 4 billion, consisting of an equity raise and conversion of state-backed debt into perpetual hybrid bonds. The group aims to raise EUR 1 billion of fresh equity (current market cap of EUR 2.2 billion), while EUR 3 billion of the EUR 7 billion French-backed loan will be converted to Super-Subordinated notes with a non-call period ranging between 4-6 years. Once successfully concluded, the group should see its negative equity balance of EUR 5.4 billion be reduced by EUR 4 billion and extend its debt redemption profile. The restructuring and cash inflow from the equity raise will benefit only the Air France operations of the group. The group will still operate with a negative equity balance, and a second capital restructuring program will be required to fully restore the balance sheet, which will be addressed at the group’s 2022 AGM. We previously estimated that the group will require a capital restructuring to the tune of EUR 4 billion and believe these measures go a long way to restore the balance sheet. We make no changes to our fair value estimate of EUR 6.10 per share and maintain our extreme uncertainty rating.

Air France-KLM is a European network carrier with major hubs at Charles de Gaulle Airport in Paris and Schiphol Airport in Amsterdam. The coronavirus dealt a heavy blow to the global airline industry, including Air France-KLM. We believe the crisis presents the group with a unique opportunity to restructure its cost base and renegotiate restrictive labor policies. The more imminent item on the group’s agenda is its unsustainable capital structure, which requires urgent restructuring. As a result, we are negative on the prospects for the group to generate shareholder value due to the high probability of value destruction.

Globally, airlines enjoyed a strong run in recent share price performance, with the average price appreciation of the six European airlines in our coverage of 17% over the past month. Aside from Ryanair and Wizz Air, which are trading above precoronavirus levels, the balance of our coverage remains below precrisis levels as the pandemic continues to challenge industry balance sheets and cash flows amid a prolonged recovery due to persistent travel restrictions. Besides, increased talk by governments of vaccine passports, which could pave the way for reopening travel, we find little fundamental news that has changed the sector’s prospects, and believe most of the price increases may be attributed to a rotation of capital into unloved sectors from high-flying tech names, which have seen a retreat from recent highs. EasyJet (fair value estimate: GBX 1,090) continues to offer the best risk-adjusted upside in the sector, while low-cost peers Ryanair (FVE: EUR 14.50) and Wizz Air (FVE: GBX 5,000) are trading above our fair value estimates. The legacy carriers, Air France-KLM, Deutsche Lufthansa and International Airlines Group, are trading well below our fair value estimates but come with very high to extreme uncertainty as they face a high probability of capital restructuring, which could hit equity values.

No-moat Air France-KLM reported messy full-year 2020 numbers, with the key question on investors’ minds relating to the balance sheet restructuring and cost-reduction efforts. We previously noted the group’s high debt levels and negative equity balance could lead to a potential capital restructure. The group is in talks with the Dutch and French governments to convert a portion of the government-backed debt into equity. Management was unclear about the absolute amount to be converted and expects to reach an agreement within the next couple of weeks. We estimate the group requires about EUR 4 billion of equity to restore the balance sheet, and with a prevailing market cap of EUR 2.1 billion could lead to major shareholder dilution. Cost-restructuring efforts are underway, with a target of 10% in unit cost savings when traffic recovers to 2019 levels. We will make changes to our short-term forecasts to reflect the longer-than-expected recovery in passenger traffic, but don’t anticipate it would have a material impact on our EUR 6.70 fair value estimate. We caution investors about the extreme uncertainty surrounding the stock and to take a wait-and-see approach until there is more clarity around the capital restructure.

We are initiating coverage of six European airlines with no-moat and stable trend ratings: Ryanair (with a fair value estimate of EUR 14.50), Wizz Air (GBX 5,000), EasyJet (GBX 1,090), International Airlines Group (GBX 320), Deutsche Lufthansa (EUR 14) and Air France-KLM (EUR 6.70). Our no-moat rating for the industry is predicated on low barriers to entry and irrational competition characterized by deflationary pricing, making it difficult to sustain economic profits.